Gold Mining Stocks – 3 Reasons the Worst is Over

The worm may finally be turning for this downtrodden sector

In terms of the similarities, one of the key drivers of this move is the falling dollar. The downturn in the greenback has accelerated in the past week, providing a boost to both physical gold and mining stocks alike. In the past five years, GDX has posted a -0.46 correlation with the PowerShares DB US Dollar Index Bullish Fund (UUP) – indicating that the two typically move in essentially the opposite direction.

The second important factor is that both stocks and gold have been rising simultaneously, which is the key to performance for mining stocks. SPY had gained 3.3% in the weekly interval ended on Tuesday, while SPDR Gold Trust (GLD) was up 5.3%. Typically, gold stocks have responded very well to this combination.

Both of these factors, while positive, aren’t necessarily sustainable. The dollar is reaching a support line established over the past two years, while the move in equities – although exceptionally robust – may be reaching the point of exhaustion. Fortunately, three new positive factors are coming into play.

First, and most important, earnings estimates are stabilizing. In the past sixty days, 2013 estimates for the major gold miners have begun to tick up. In most cases, the increase is very modest. For instance, Goldcorp‘s (GG) EPS estimates have climbed from $0.91 to $0.95, while Barrick Gold‘s (ABX) have inched up from $2.57 to $2.64. Newmont Mining (NEM), Anglogold Ashanti (AU), and Gold Fields Ltd. (GFI) have shown similar gains. This positive rate of change marks a significant departure from the steady stream of bad news investors have had to endure in recent years.

The second factor working in gold stocks’ favor is that analysts are growing optimistic again. Yesterday, HSBC put out a bullish note on gold and upgraded Agnico Eagle Mines (AEM), Yamana Gold (AUY), Barrick Gold, Iamgold (IAG), and Goldcorp. Most gold stocks are ranked “Hold” or “Buy” (as opposed to “Strong Buy”) by the majority of analysts, meaning that there’s plenty of room for continued positive news flow on this front.

The technical picture is also improving. Gold stocks are roughly flat in the past three months, and have formed a broad base with the same type of double-bottom formation that preceded a rally of close to 40% in the summer of 2012:

Gold stocks are still a risky proposition. Any time a sector has underperformed for as long as the miners have, the utmost caution is necessary. Still, this is a small sector where a relatively small improvement in marginal investment inflows can have a major impact, and where the massive downturn of the two years means that there’s a substantial amount of upside potential.

With the headwinds to the sector beginning to dissipate, it’s finally time for investors to put gold stocks on their radar screen again.

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.